Ch15

CHAPTER 15

Equity

ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)

Topics QuestionsBrief

Exercises Exercises Problems Concepts for Analysis

1. Shareholders’ rights;corporate form.

1, 2, 3 1

2. Equity. 4, 5, 6, 16, 17, 18, 29,30, 31

3 7, 10, 16, 17

1, 2, 3, 9

3. Issuance of shares. 7, 10 1, 2, 6 1, 2, 4,6, 9

1, 3, 4

4. Noncash share transactions; lump sum sales.

8, 9 4, 5 3, 4, 5, 6 1, 4 2

5. Treasury share transactions, cost method.

11, 12, 17 7, 8 3, 6, 7, 9, 10, 18

1, 2, 3,5, 6, 7

7

6. Preference stock. 3, 13, 14, 15

9 2, 8 1, 3

7. Equity accounts; classifications; terminology.

10, 11, 16, 17

9, 11, 12 3

8. Dividend policy. 19, 20, 21,22, 25, 26

10 12, 15 7, 10

9. Cash and share dividends; share splits; property dividends; liquidating dividends.

22, 23, 24 10, 11, 12, 13, 14

13, 14,15, 18

6, 7, 8, 10, 11

4, 5, 6

10. Restrictions of retained earnings.

27, 28 9

11. Presentation and analysis 17, 19, 20 12

*12. Dividend preferences and book value.

32 15 21, 22, 23, 24

*This material is covered in an Appendix to the chapter.

Copyright © 2011 John Wiley & Sons, Inc. Kieso Intermediate: IFRS Edition, Solutions Manual 15-1

ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)

Learning Objectives Brief Exercises Exercises Problems

1. Discuss the characteristics of the corporate form of organization.

2. Identify the key components of equity.

3. Explain the accounting procedures for issuing shares.

1, 2, 4, 5, 6 1, 2, 3, 4, 5, 6, 8, 9, 10

1, 3, 4, 9, 12

4. Describe the accounting for treasury shares. 3, 7, 8 6, 7, 9, 10, 18 1, 2, 3, 5, 6, 7, 9, 12

5. Explain the accounting for and reporting of preference shares.

9 5, 8 4

6. Describe the policies used in distributing dividends.

10, 11, 12 16

7. Identify the various forms of dividend distributions.

11, 12 11, 12, 15, 16, 18

3, 6, 7, 8, 9, 11, 12

8. Explain the accounting for small and large share dividends, and for share splits.

13, 14 11, 13, 14, 15, 16, 18

3, 8, 10, 11, 12

9. Indicate how to present and analyze equity. 3 17, 19, 20 1, 2, 6, 9,11, 12

*10. Explain the different types of preference share dividends and their effect on book value per share.

15 8, 21, 22, 23, 24

15-2 Copyright © 2011 John Wiley & Sons, Inc. Kieso, Intermediate: IFRS Edition, Solutions Manual

ASSIGNMENT CHARACTERISTICS TABLE

Item DescriptionLevel ofDifficulty

Time(minutes)

E15-1 Recording the issuances of ordinary shares. Simple 15–20E15-2 Recording the issuance of ordinary and preference shares. Simple 15–20E15-3 Shares issued for land. Simple 10–15E15-4 Lump-sum sale of shares with bonds. Moderate 20–25E15-5 Lump-sum sales of ordinary and preference shares. Simple 10–15E15-6 Share issuances and repurchase. Moderate 25–30E15-7 Effect of treasury share transactions on financials. Moderate 15–20E15-8 Preference share entries and dividends. Moderate 15–20E15-9 Correcting entries for equity transactions. Moderate 15–20E15-10 Analysis of equity data and equity section preparation. Moderate 20–25E15-11 Equity items on the statement of financial position. Simple 15–20E15-12 Cash dividend and liquidating dividend. Simple 10–15E15-13 Share split and share dividend. Simple 10–15E15-14 Entries for share dividends and share splits. Simple 10–12E15-15 Dividend entries. Simple 10–15E15-16 Computation of retained earnings. Simple 05–10E15-17 Equity section. Moderate 20–25E15-18 Dividends and equity section. Moderate 30–35E15-19 Comparison of alternative forms of financing. Moderate 20–25E15-20 Trading on the equity analysis. Moderate 15–20*E15-21 Preference dividends. Simple 10–15*E15-22 Preference dividends. Moderate 15–20*E15-23 Preference share dividends. Complex 15–20*E15-24 Computation of book value per share. Moderate 10–20

P15-1 Equity transactions and statement preparation. Moderate 50–60P15-2 Treasury share transactions and presentation. Simple 25–35P15-3 Equity transactions and statement preparation. Moderate 25–30P15-4 Share transactions—lump sum. Moderate 20–30P15-5 Treasury shares—cost method. Moderate 30–40P15-6 Treasury shares—cost method—equity section preparation. Moderate 30–40P15-7 Cash dividend entries. Moderate 15–20P15-8 Dividends and splits. Moderate 20–25P15-9 Equity section of statement of financial position. Simple 20–25P15-10 Share dividends and share split. Moderate 35–45P15-11 Share and cash dividends. Simple 25–35P15-12 Analysis and classification of equity transactions. Complex 35–45

CA15-1 Preemptive rights and dilution of ownership. Moderate 10–20CA15-2 Issuance of shares for land. Moderate 15–20CA15-3 Conceptual issues—equity. Moderate 25–30CA15-4 Share dividends and splits. Simple 25–30CA15-5 Share dividends. Simple 15–20CA15-6 Share dividend, cash dividend, and treasury shares. Moderate 20–25CA15-7 Treasury shares, ethics. Moderate 10–15

*This material is presented in an appendix to the chapter.


ANSWERS TO QUESTIONS

1. The basic rights of each shareholder (unless otherwise restricted) are to share proportionately: (1) in profits, (2) in management (the right to vote for directors), (3) in corporate assets upon liquidation, and (4) in any new issues of shares of the same class (preemptive right).

2. The preemptive right protects existing shareholders from dilution of their ownership share in the event the corporation issues new shares.

3. Preference shares commonly have preference to dividends in the form of a fixed dividend rate and a preference over ordinary shares to remaining corporate assets in the event of liquidation. Preference shares usually do not give the holder the right to share in the management of the company. Ordinary shares are the residual security possessing the greater risk of loss and the greater potential for gain; they are guaranteed neither dividends nor assets upon dissolution but they generally control the management.

4. The distinction between contributed (paid-in) capital and retained earnings is important for both legal and economic points of view. Legally, dividends can be declared out of retained earnings in all countries, but in many countries dividends cannot be declared out of contributed (paid-in) capital. Economically, management, shareholders, and others look to earnings for the continued existence and growth of the corporation.

5. Authorized ordinary shares—the total number of shares authorized by the country of incorporation for issuance.Unissued ordinary shares—the total number of shares authorized but not issued.Issued ordinary shares—the total number of shares issued (distributed to shareholders).Outstanding ordinary shares—the total number of shares issued and still in the hands of shareholders (issued less treasury shares).Treasury shares—shares issued and repurchased by the issuing corporation but not retired.

6. Par value is an arbitrary, fixed per share amount assigned to a share by the incorporators. It is recognized as the amount that must be paid in for each share if the shares are to be fully paid when issued. If not fully paid, the shareholder has a contingent liability for the discount results.

7. The issuance for cash of no-par value ordinary shares at a price in excess of the stated value of the ordinary shares is accounted for as follows:(1) Cash is debited for the proceeds from the issuance of the ordinary shares.(2) Share Capital—Ordinary is credited for the stated value of the ordinary shares.(3) Share Premium—Ordinary is credited for the excess of the proceeds from the issuance of

the ordinary shares over their stated value.

8. The proportional method is used to allocate the lump sum received on sales of two or more classes of securities when the fair value or other sound basis for determining relative value is available for each class of security. In instances where the fair value of all classes of securities is not determinable in a lump-sum sale, the incremental method must be used. The value of the securities is used for those classes that are known and the remainder is allocated to the class for which the value is not known.


Questions Chapter 15 (Continued)

9. The general rule to be applied when shares are issued for services or property other than cash is that companies should record the shares issued at the fair value of the goods or services received, unless that fair value cannot be measured reliably. If the fair value of the goods or services cannot be measured reliably, use the fair value of the shares issued. If a company cannot readily determine either the fair value of the shares it issues or the property or services it receives, it should employ an appropriate valuation technique. Depending on available data, the valuation may be based on market transactions involving comparable assets or the use of discounted expected future cash flows. Companies should avoid the use of the book, par, or stated values as a basis of valuation for these transactions.

10. The direct costs of issuing shares, such as underwriting costs, accounting and legal fees, printing costs, and taxes, should be reported as a reduction of the amounts paid in. Issue costs are there-fore debited to Share Premium because they are unrelated to corporate operations.

11. The major reasons for purchasing its own shares are: (1) to provide tax-efficient distributions of excess cash to shareholders, (2) to increase earnings per share and return on equity, (3) to provide shares for employee compensation contracts, (4) to thwart takeover attempts or to reduce the number of shareholders, (5) to make a market in the company’s shares.

12. (a) Treasury shares should not be classified as an asset since a corporation cannot own itself.

(b) The “gain” or “loss” on sale of treasury shares should not be treated as additions to or deductions from income. If treasury shares are carried in the accounts at cost, these so-called gains or losses arise when the treasury shares are sold. These “gains” or “losses” should be considered as additions to or reductions of equity. In some instances, the “loss” should be charged to Retained Earnings. “Gains” or “losses” arising from treasury shares transactions are not included as a component of net income since dealings in treasury shares represent equity transactions.

(c) Dividends on treasury shares should never be included as income, but should be credited directly to retained earnings, against which they were incorrectly charged. Since treasury shares cannot be considered an asset, dividends on treasury shares are not properly included in net income.

13. The character of preference shares can be altered by being cumulative or non-cumulative, partici-pating or non-participating, convertible or non-convertible, and/or callable or non-callable.

14. Nonparticipating means the security holder is entitled to no more than the specified fixed dividend. If the security is partially participating, it means that in addition to the specified fixed dividend the security may participate with the ordinary shares in dividends up to a certain stated rate or amount. A fully participating security shares pro rata with the ordinary shares dividends declared without limitation. In this case, Kim Inc. has fully participating preference shares. Cumulative means dividends not paid in any year must be made up in a later year before any profits can be distributed to ordinary shareholders. Any dividends not paid on cumulative preference shares constitute a dividend in arrears. A dividend in arrears is not a liability until the board of directors declares a dividend.

15. Preference shares are generally reported at par value as the first item in the equity section of a company’s statement of financial position. Any excess over par value is reported as share premium-preference.

16. Sources of equity include (1) share capital, (2) share premium, (3) retained earnings, (4) accumulated other comprehensive income, and reduced by (5) treasury shares.



17. When treasury shares are purchased, the Treasury Shares account is debited and Cash is credited at cost (€290,000 in this case). Treasury Shares is a contra equity account and Cash is an asset. Thus, this transaction has: (a) no effect on net income, (b) decreases total assets, (c) has no effect on retained earnings, and (d) decreases total equity.

18. The answers are summarized in the table below:Account Classification

(a) Share capital—ordinary Share capital(b) Retained Earnings Retained earnings(c) Share Premium—Ordinary Share premium(d) Treasury Shares Deducted from total equity(e) Share Premium—Treasury Share premium(f) Accumulated Other Comprehensive Income Added to total equity(g) Share capital—preference Share capital

19. The dividend policy of a company is influenced by (1) the availability of cash, (2) the stability of earnings, (3) current earnings, (4) prospective earnings, (5) the existence or absence of contractual restrictions on working capital or retained earnings, and (6) a retained earnings balance.

20. In declaring a dividend, the board of directors must consider the condition of the corporation such that a dividend is (1) legally permissible and (2) economically sound.

In general, directors should give consideration to the following factors in determining the legality of a dividend declaration:(1) Retained earnings, unless legally encumbered in some manner, is usually the correct basis

for dividend distribution.(2) Dividends in some jurisdictions may not reduce retained earnings below the cost of treasury

shares held.

In addition, in some jurisdictions, share premium may be used for dividends, although such dividends may be limited to preference shares. Generally, deficits in retained earnings and debits in contributed (paid-in) capital accounts must be restored before payment of any dividends.

In order that dividends be economically sound, the board of directors should consider: (1) the availability (liquidity) of assets for distribution; (2) agreements with creditors; (3) the effect of a dividend on investor perceptions (e.g. maintaining an expected “pay-out ratio”); and (4) the size of the dividend with respect to the possibility of paying dividends in future bad years. In addition, the ability to expand or replace existing facilities should be considered.

21. Cash dividends are paid out of cash. A balance must exist in retained earnings to permit a legal distribution of profits, but having a balance in retained earnings does not ensure the ability to pay a dividend if the cash situation does not permit it.

22. A cash dividend is a distribution in cash while a property dividend is a distribution in assets other than cash. Any dividend not based on retained earnings is a liquidating dividend. A share dividend is the issuance of additional shares in a nonreciprocal exchange involving existing shareholders with no change in the par or stated value.

23. A share dividend results in the transfer from retained earnings to share capital and share premium of an amount equal to the market value of each share (if the dividend is less than 20–25%) or the par value of each share (if the dividend is greater than 20–25%). No formal journal entries are required for a share split, but a notation in the ledger accounts would be appropriate to show that the par value of the shares has changed.



24. (a) A share split effected in the form of a dividend is a distribution of corporate shares to present shareholders in proportion to each shareholder’s current holdings and can be expected to cause a material decrease in the market value per share. IFRS specifies that a distribution in excess of 20% to 25% of the number of shares previously outstanding would cause a material decrease in the market value. This is a characteristic of a share split as opposed to a share dividend, but, for legal reasons, the term “dividend” must be used for this distribution. From an accounting viewpoint, it should be disclosed as a share split effected in the form of a dividend because it meets the accounting definition of a share split as explained above.

(b) The share split effected in the form of a dividend differs from an ordinary share dividend in the amount of retained earnings to be capitalized. An ordinary share dividend involves capitalizing (charging) retained earnings equal to the fair value of the shares distributed. A share split effected in the form of a dividend involves charging retained earnings for the par (stated) value of the additional shares issued.

Another distinction between a share dividend and a share split is that a share dividend usually involves distributing additional shares of the same class with the same par or stated value. A share split usually involves distributing additional shares of the same class but with a proportionate reduction in par or stated value. The aggregate par or stated value would then be the same before and after the share split.

(c) A declared but unissued share dividend should be classified as part of equity rather than as a liability in a statement of financial position. A share dividend affects only equity accounts; that is, retained earnings is decreased and share capital and share premium are increased. Thus, there is no debt to be paid, and, consequently, there is no severance of corporate assets when a share dividend is issued. Furthermore, share dividends declared can be revoked by a corporation’s board of directors any time prior to issuance. Finally, the corporation usually will formally announce its intent to issue a specific number of additional shares, and these shares must be reserved for this purpose.

25. A partially liquidating dividend will be debited both to Retained Earnings and Share Premium. The portion of dividends that is a return of capital should be debited to Share Premium.

26. A property dividend is a nonreciprocal transfer of nonmonetary assets between an enterprise and its owners. A transfer of a nonmonetary asset to a shareholder or to another entity in a nonreciprocal transfer should be recorded at the fair value of the asset transferred, and a gain or loss should be recognized on the disposition of the asset.

27. Retained earnings are restricted because of legal or contractual restrictions, or the necessity to protect the working capital position.

28. Restrictions of retained earnings are best disclosed in a note to the financial statements. This allows a more complete explanation of the restriction.

29. No, Mary should not make that conclusion. While IFRS allows unrealized losses on non-trading equity investments to be reported under “Reserves”, U.S. GAAP requires these losses to be reported as other comprehensive income. Specifically, unrealized losses are reported in the Accumulated Other Comprehensive Income (Loss) account under U.S. GAAP.

30. Key similarities between IFRS and U.S. GAAP for transactions related to equity pertain to (1) issuance of shares, (2) purchase of treasury shares, (3) declaration and payment of dividends, (4), the costs associated with issuing shares reduce the proceeds from the issuance and reduce contributed (paid-in) capital, and (5) the accounting for par, no par and no par shares with a stated value.



Major differences relate to terminology used, introduction of items such as revaluation surplus, and presentation of stockholder equity information. In addition, the accounting for treasury stock retirements differs between IFRS and U.S. GAAP. Under U.S. GAAP a company has the option of charging the excess of the cost of treasury stock over par value to (1) retained earnings, (2) allocate the difference between paid in capital and retained earnings, or (3) charge the entire amount to paid-in capital. Under IFRS, the excess may have to be charged to paid-in capital, depending on the original transaction related to the issuance of the stock. An IFRS/U.S. GAAP difference relates to the account Revaluation Surplus. Revaluation surplus arises under IFRS because of increases or decreases in property, plant and equipment, mineral resources, and intangible assets. This account is part of general reserves under IFRS and is not considered contributed capital.

31. It is likely that the statement of stockholders’ equity and its presentation will be examined closely in the financial statement presentation project. In addition the options of how to present other comprehensive income under U.S. GAAP will change in any converged standard in this area.

*32. Preference Ordinary Total

(a) Current year’s dividend, 7% $ 7,000 $21,000a $28,000

Participating dividend of 9% 9,000 27,000 36,000

Totals $16,000 $48,000 $64,000

a(see schedule below for computation of amounts)

The participating dividend was determined as follows:

Current year’s dividend:Preference, 7% of $100,000 = $ 7,000

Ordinary, 7% of $300,000 = 21,000 $28,000

Amount available for participation($64,000 – $28,000) $36,000

Par value of stock that is to participate($100,000 + $300,000) $400,000

Rate of participation($36,000 ÷ $400,000) 9%

Participating dividend:Preference, 9% of $100,000 $ 9,000

Ordinary, 9% of $300,000 27,000Dividends $36,000



(b) Preference Ordinary Total

Dividends in arrears, 7% of $100,000 $ 7,000 $ 7,000

Current year’s dividend, 7% 7,000 $21,000 28,000

Participating dividend 7.25% ($29,000 ÷ $400,000)* 7,250 21,750 29,000

Totals $21,250 $42,750 $64,000

*(The same type of schedule as shown in (a)

could be used here)

(c) Preference Ordinary Total

Dividends in arrears ($100,000 X 7%) – $5,000 $2,000 $ 2,000

Current year’s dividend, 7% 7,000 7,000

Remainder to common $21,000 21,000

Totals $9,000 $21,000 $30,000


SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 15-1

Cash..................................................................................... 4,500Share Capital—Ordinary (300 X €10)......................... 3,000Share Premium—Ordinary......................................... 1,500

BRIEF EXERCISE 15-2

(a) Cash............................................................................. 8,200Share Capital—Ordinary.................................... 8,200

(b) Cash............................................................................. 8,200Share Capital—Ordinary (600 X €2)................... 1,200Share Premium—Ordinary................................. 7,000

BRIEF EXERCISE 15-3

WILCO CORPORATIONEquity

December 31, 2010

Share Capital—Ordinary, €5 par value............................. € 510,000Share Premium—Ordinary................................................ 1,320,000Retained earnings.............................................................. 2,340,000Less: Treasury shares....................................................... (90,000 )

Total equity................................................................. € 4,080,000

BRIEF EXERCISE 15-4

Cash.................................................................................... 13,500Share Capital—Preference (100 X $50)..................... 5,000Share Premium—Preference..................................... 3,100Share Capital—Ordinary (300 X $10)........................ 3,000Share Premium—Ordinary......................................... 2,400

FV of ordinary (300 X $20)................................................. $ 6,000FV of preference (100 X $90)............................................. 9,000

Total FV....................................................................... $15,000


BRIEF EXERCISE 15-4 (Continued)

Allocated to ordinary $15,000

$6,000 X $13,500 = $ 5,400

Allocated to preference $15,000

$9,000 X $13,500 = 8,100

BRIEF EXERCISE 15-5

Land..................................................................................... 31,000Share Capital—Ordinary (3,000 X £5)....................... 15,000Share Premium—Ordinary......................................... 16,000

BRIEF EXERCISE 15-6

Cash ($60,000 – $1,500)..................................................... 58,500Share Capital—Ordinary (2,000 X $10)..................... 20,000Share Premium—Ordinary......................................... 38,500

BRIEF EXERCISE 15-7

7/1/10 Treasury Shares (100 X €87)............................. 8,700Cash............................................................ 8,700

9/1/10 Cash (60 X €90).................................................. 5,400Treasury Shares (60 X €87)....................... 5,220Share Premium—Treasury........................ 180

11/1/10 Cash (40 X €83).................................................. 3,320Share Premium—Treasury............................... 160

Treasury Shares (40 X €87)....................... 3,480


$13,500

BRIEF EXERCISE 15-8

8/1/10 Treasury Shares (200 X $80)........................ 16,000Cash....................................................... 16,000

11/1/10 Cash (200 X $70)........................................... 14,000Retained Earnings........................................ 2,000

Treasury Shares.................................... 16,000

BRIEF EXERCISE 15-9

Cash................................................................................ 61,500Share Capital—Preference (500 X €100).............. 50,000Share Premium—Preference................................ 11,500

BRIEF EXERCISE 15-10

Aug. 1 Retained Earnings (2,000,000 X $1)................................2,000,000Dividends Payable................................................... 2,000,000

Aug. 15 No entry.

Sep. 9 Dividends Payable............................................................2,000,000Cash.......................................................................... 2,000,000


Sep. 21 Equity Investments...........................................................325,000Unrealized Holding Gain or Loss— OCI (R$1,200,000 – R$875,000).............................. 325,000

Retained Earnings (Property Dividends Declared).....................................1,200,000

Property Dividends Payable................................... 1,200,000

Oct. 8 No entry.

Oct. 23 Property Dividends Payable............................................1,200,000Equity Investments.................................................. 1,200,000



Apr. 20 Retained Earnings (¥500,000 – ¥125,000).......................375,000

Share Premium—Ordinary...............................................125,000

Dividends Payable................................................... 500,000

June 1 Dividends Payable............................................................500,000

Cash.......................................................................... 500,000


Declaration Date.

Retained Earnings............................................................ 1,300,000

Ordinary Share Dividend Distributable.................. 200,000

Share Premium—Ordinary...................................... 1,100,000

(20,000* X $65 = $1,300,000;

( 20,000 X $10 = $200,000)

*200,000 shares X 10%

Distribution Date.

Ordinary Share Dividend Distributable........................... 200,000

Share Capital—Ordinary......................................... 200,000


Declaration Date.

Retained Earnings............................................................ 4,000,000

Ordinary Share Dividend Distributable

(400,000 X $10)...................................................... 4,000,000

Distribution Date.

Ordinary Share Dividend Distributable........................... 4,000,000

Share Capital—Ordinary......................................... 4,000,000


*BRIEF EXERCISE 15-15

(a) Preference shareholders would receive $60,000 (6% X $1,000,000) and the remainder of $240,000 ($300,000 – $60,000) would be distributed to ordinary shareholders.

(b) Preference shareholders would receive $180,000 (6% X $1,000,000 X 3) and the remainder of $120,000 would be distributed to the ordinary shareholders.


SOLUTIONS TO EXERCISES

EXERCISE 15-1 (15–20 minutes)

(a) Jan. 10 Cash (80,000 X €6)................................. 480,000Share Capital—Ordinary (80,000 X €3).................................. 240,000Share Premium—Ordinary............. 240,000

Mar. 1 Organization Expense........................... 35,000Share Capital—Ordinary (5,000 X €3).................................... 15,000Share Premium—Ordinary............. 20,000

July 1 Cash (30,000 X €8)................................. 240,000Share Capital—Ordinary (30,000 X €3).................................. 90,000Share Premium—Ordinary (30,000 X €5)................................. 150,000

Sept. 1 Cash (60,000 X €10)............................... 600,000Share Capital—Ordinary (60,000 X €3).................................. 180,000Share Premium—Ordinary (60,000 X €7)................................. 420,000

(b) If the shares have a stated value of €2 per share, the entries in (a) would be the same except for the euro amounts. For example, the Jan. 10 entry would include credits of €160,000 to Share Capital—Ordinary and €320,000 to Share Premium—Ordinary.



Jan. 10 Cash (80,000 X $5)......................................... 400,000Share Capital—Ordinary (80,000 X $2)......................................... 160,000Share Premium—Ordinary (80,000 X $3)......................................... 240,000

Mar. 1 Cash (5,000 X $108)....................................... 540,000Share Capital—Preference (5,000 X $50)......................................... 250,000Share Premium—Preference (5,000 X $58)......................................... 290,000

April 1 Land................................................................ 80,000Share Capital—Ordinary (24,000 X $2)......................................... 48,000Share Premium—Ordinary ($80,000 – $48,000)............................... 32,000

May 1 Cash (80,000 X $7)......................................... 560,000Share Capital—Ordinary (80,000 X $2)......................................... 160,000Share Premium—Ordinary (80,000 X $5)......................................... 400,000

Aug. 1 Organization Expense................................... 50,000Share Capital—Ordinary (10,000 X $2)......................................... 20,000Share Premium—Ordinary ($50,000 – $20,000)............................... 30,000

Sept. 1 Cash (10,000 X $9)......................................... 90,000Share Capital—Ordinary (10,000 X $2)......................................... 20,000Share Premium—Ordinary (10,000 X $7)......................................... 70,000

Nov. 1 Cash (1,000 X $112)....................................... 112,000Share Capital—Preference (1,000 X $50)......................................... 50,000Share Premium—Preference (1,000 X $62)......................................... 62,000



(a) Land ($60 X 25,000).................................................. 1,500,000Treasury Shares ($48 X 25,000)...................... 1,200,000Share Premium—Treasury.............................. 300,000

(b) One might use the cost of treasury shares. However, this is not a relevant measure of this economic event. Rather, it is a measure of a prior, unrelated event. The appraised value of the land is a reasonable alternative (if based on appropriate fair value estimation techniques). However, it is an appraisal as opposed to a market-determined price. The trading price of the shares is probably the best measure of fair value in this transaction.


(a) (1) Cash ($850 X 9,600).............................................. 8,160,000Bonds Payable ($5,000,000 – $200,000*).... 4,800,000Share Capital—Ordinary (100,000 X $5)..... 500,000Share Premium—Ordinary........................... 2,860,000

*[$340,000 ($850 X 400) X $500/$850]

Assumes bonds are properly priced and issued at par; the residual attributed to share capital has a questionable measure of fair value.

Incremental method

Lump-sum receipt (9,600 X $850)............................. $8,160,000Allocated to subordinated debenture (9,600 X $500)........................................................... (4,800,000)Balance allocated to ordinary shares....................... $3,360,000

Computation of share capital and share premium

Balance allocated to ordinary shares....................... $3,360,000Less: Share capital (10,000 X $5 X 10)..................... 500,000Share premium........................................................... $2,860,000


EXERCISE 15-4 (Continued)

Bond issue cost allocation

Total issue cost (400 X $850)........................... $ 340,000Less: Amount allocated to bonds................... 200,000Amount allocated to ordinary shares.............. $ 140,000

Investment banking costs 400 @ $850 = $340,000 allocate 5/8.5 to debentures and 3.5/8.5 to ordinary shares. Bond portion is bond issue costs; share capital portion is a reduction of share premium, which means that total contributed (paid-in) capital is $3,360,000 ($3,500,000 – $140,000).

(2) Cash................................................................... 8,160,000Bonds Payable........................................... 4,533,333Share Capital—Ordinary (100,000 X $5).......................................... 500,000Share Premium—Ordinary....................... 3,126,667

The allocation based on fair value for one unit isSubordinated debenture........................... $500Ordinary shares (10 shares X $40).......... 400Total fair value........................................... $900

Therefore 5/9 is allocated to the bonds and 4/9 to the ordinary shares.

$8,500,000 X (5/9) = $4,722,222 To Debentures$8,500,000 X (4/9) = $3,777,778 To Ordinary Shares$340,000 X (5/9) = $188,889$340,000 X (4/9) = $151,111Share Premium = $3,777,778 – $500,000 – $151,111

= $3,126,667

(b) One is not better than the other, but would depend on the relative reliability of the valuations for the shares and bonds. This question is presented to stimulate some thought and class discussion.



(a) Fair value of Ordinary Shares (500 X €168)........... € 84,000Fair value of Preference Shares (100 X €210)....... 21,000

€ 105,000

Allocated to Ordinary Shares: €84,000/€105,000 X €100,000................................ € 80,000Allocated to Preference Shares: €21,000/€105,000 X €100,000................................ 20,000Total allocation........................................................ € 100,000

Cash.......................................................................... 100,000Share Capital—Ordinary (500 X €10)............... 5,000Share Premium—Ordinary (€80,000 – €5,000)........................................... 75,000Share Capital—Preference (100 X €100).......... 10,000Share Premium—Preference (€20,000 – €10,000).......................................... 10,000

(b) Lump-sum receipt €100,000Allocated to ordinary (500 X €170) (85,000 )Balance allocated to preference € 15,000

Cash.......................................................................... 100,000Share Capital—Ordinary................................... 5,000Share Premium—Ordinary (€85,000 – €5,000)........................................... 80,000Share Capital—Preference............................... 10,000Share Premium—Preference (€15,000 – €10,000).......................................... 5,000


(a) Cash [(5,000 X $45) – $7,000]..................................... 218,000Share Capital—Ordinary (5,000 X $10).............. 50,000Share Premium—Ordinary................................. 168,000



(b) Land (1,000 X $46)...................................................... 46,000Share Capital—Ordinary (1,000 X $10).............. 10,000Share Premium—Ordinary ($46,000 – $10,000)........................................... 36,000

Note: The fair value of the shares ($46,000) is used to value the exchange because it is a more objective measure than the appraised value of the land ($50,000).

(c) Treasury Shares (500 X $44)..................................... 22,000Cash..................................................................... 22,000


# Assets Liabilities EquityShare

PremiumRetainedEarnings

NetIncome

1. D NE D NE NE NE2. I NE I NE D NE3. I NE I I NE NE


(a) $1,000,000 X 6% = $60,000; $60,000 X 3 = $180,000. The cumulative dividend is disclosed in a note to the equity section; it is not reported as a liability.

(b) Share Capital—Preference (3,000 X $100)............... 300,000Share Capital—Ordinary (3,000 X 7 X $10)....... 210,000Share Premium—Ordinary................................. 90,000

(c) Preference shares, $100 par 6%, 10,000 shares issued.............................................. $1,000,000Share premium—preference (10,000 X $7).............. 70,000



May 2 Cash................................................................... 192,000Share Capital—Ordinary (12,000 X $10)......................................... 120,000Share Premium—Ordinary (12,000 X $6)........................................... 72,000

10 Cash................................................................... 600,000Share Capital—Preference (10,000 X $30)......................................... 300,000Share Premium—Preference (10,000 X $30)......................................... 300,000

15 Treasury Shares................................................ 14,000Cash........................................................... 14,000

31 Cash................................................................... 8,500Treasury Shares (500 X $14).................... 7,000Share Premium—Treasury (500 X $3)..... 1,500


(a) (1) The par value is $2.50. This amount is obtained from either of the following: 2011—$545 ÷ 218 or 2010—$540 ÷ 216.

(2) The cost of treasury shares was higher in 2011. The cost at December 31, 2011 was $42 per share ($1,428 ÷ 34) compared to the cost at December 31, 2010 of $34 per share ($918 ÷ 27).

(b) Equity (in millions of dollars)Share capital—ordinary, $2.50 par value, 500,000,000 shares authorized, 218,000,000 shares issued, and 184,000,000 shares outstanding....................... $ 545Share premium—ordinary............................................ 891

Retained earnings................................................................. 7,167Less: Cost of treasury shares (34,000,000 shares).......... 1,428

Total equity............................................................ $ 7,175



Item Assets Liabilities EquityShare

PremiumRetained Earnings

Net Income

1. I NE I NE I I 2. NE NE NE NE NE NE 3. NE I D NE D NE 4. NE NE NE NE NE NE 5. D NE D NE D D 6. D D NE NE NE NE 7. NE I D NE D D 8. NE NE NE I D NE 9. NE NE NE NE NE NE


(a) 6/1 Retained Earnings............................................................6,000,000

Dividends Payable...................................................6,000,000

6/14 No entry on date of record.

6/30 Dividends Payable............................................................6,000,000

Cash..........................................................................6,000,000

(b) If this were a liquidating dividend, the debit entry on the date of declaration would be to Share Premium rather than Retained Earnings.


(a) No entry—simply a memorandum note indicating the number of shares has increased to 10 million and par value has been reduced from $10 to $5 per share.

(b) Retained Earnings ($10 X 5,000,000) 50,000,000Ordinary Share Dividend Distributable 50,000,000

Ordinary Share Dividend Distributable 50,000,000Share Capital—Ordinary 50,000,000



(c) Share dividends and splits serve the same function with regard to the securities markets. Both techniques allow the board of directors to increase the quantity of shares and reduce share prices into a desired “trading range.”

For accounting purposes the 20%–25% rule reasonably views large share dividends as substantive share splits. In this case, it is necessary to capitalize par value with a share dividend because the number of shares is increased and the par value remains the same. Earnings are capitalized for purely procedural reasons.


(a) Retained Earnings (10,000 X €37)...................................370,000Ordinary Share Dividend Distributable...................... 100,000Share Premium—Ordinary........................................... 270,000

Ordinary Share Dividend Distributable..........................100,000Share Capital—Ordinary.............................................. 100,000

(b) Retained Earnings (200,000 X €10).................................2,000,000Ordinary Share Dividend Distributable...................... 2,000,000

Ordinary Share Dividend Distributable..........................2,000,000Share Capital—Ordinary.............................................. 2,000,000

(c) No entry, the par value becomes €5 and the number of shares out-standing increases to 400,000.


(a) Retained Earnings............................................................117,000Ordinary Share Dividend Distributable.................. 30,000Share Premium—Ordinary...................................... 87,000 (60,000 shares X 5% X R39 = $117,000)

Ordinary Share Dividend Distributable..........................30,000Share Capital—Ordinary......................................... 30,000



(b) No entry; memorandum to indicate that par value is reduced to R2 and shares outstanding are now 300,000 (60,000 X 5).

(c) January 5, 2011Debt Investments..............................................................35,000

Unrealized Holding Gain or Loss—Income....................................................... 35,000

Retained Earnings............................................................125,000Property Dividends Payable................................... 125,000

January 25, 2011Property Dividends Payable............................................125,000

Debt Investments..................................................... 125,000


Total income since incorporation.............................. W287,000Less: Total cash dividends paid............................... W60,000

Total value of share dividends....................... 40,000 100,000 Current balance of retained earnings....................... W 187,000

The accumulated other comprehensive income is shown as part of equity; the gains on treasury share transactions are recorded as share premium.



TELLER CORPORATIONPartial Statement of Financial Position

December 31, 2010

Equity Share capital—preference, €4 cumulative, par value €50 per share; authorized 60,000 shares, issued and outstanding 10,000 shares.................................€ 500,000 Share capital—ordinary, par value €1 per share; authorized 600,000 shares, issued 200,000 shares, and outstanding 190,000 shares................. 200,000 € 700,000 Share premium—Ordinary........................................... 1,000,000 Share premium—Treasury........................................... 160,000 1,160,000 Retained earnings......................................................... 201,000 Treasury shares, 10,000 shares at cost...................... ( 170,000)

Total equity............................................................ € 1,891,000


(a) 1. Dividends Payable—Preference (2,000 X $8).....................................................................16,000Dividends Payable—Ordinary (20,000 X $2)...................................................................40,000

Cash.......................................................................... 56,000

2. Treasury Shares...............................................................108,000Cash (2,700 X $40)................................................... 108,000

3. Land...................................................................................30,000Treasury Shares (700 X $40)................................... 28,000Share Premium—Treasury..................................... 2,000

4. Cash (500 X $105).............................................................52,500Share Capital—Preference (500 X $100)........................................................... 50,000Share Premium—Preference.................................. 2,500



5. Retained Earnings (1,800* X $45)....................................81,000Ordinary Share Dividend Distributable (1,800 X $5)............................................................ 9,000Share Premium—Ordinary...................................... 72,000

*(20,000 – 2,700 + 700 = 18,000; 18,000 X 10%)

6. Ordinary Share Dividend Distributable..........................9,000Share Capital—Ordinary......................................... 9,000

7. Retained Earnings............................................................59,600Dividends Payable—Preference (2,500 X $8)............................................................ 20,000Dividends Payable—Ordinary (19,800* X $2)........................................................ 39,600

*(18,000 + 1,800)

(b) ELIZABETH COMPANY

Partial Statement of Financial PositionDecember 31, 2011

Equity Share capital—preference shares, 8%, $100 par, 10,000 shares authorized, 2,500 shares issued and outstanding............................................................$250,000 Share capital—ordinary stock, $5 par, 100,000 shares authorized, 21,800 shares issued, 19,800 shares outstanding............................................... 109,000 $ 359,000 Share premium......................................................... 201,500 Retained earnings.................................................... 639,400 Treasury shares (2,000 ordinary shares) (80,000)

Total equity $1,119,900



Computations:Preference shares $200,000 + $50,000 = $250,000Ordinary shares $100,000 + $ 9,000 = $109,000Share premium: $125,000 + $2,000 + $2,500 + $72,000 = $201,500

Retained earnings: $450,000 – $81,000 – $59,600 + $330,000 = $639,400

Treasury shares $108,000 – $28,000 = $80,000


(a) Wilder Company is the more profitable in terms of rate of return on total assets. This may be shown as follows:

Wilder Company $720,000 = 17.14%$4,200,000

Ingalls Company $648,000 = 15.43%$4,200,000

Note to Instructor: These returns are based on net income related to total assets, where the ending amount of total assets is considered representative. If the rate of return on total assets uses net income before interest but after taxes in the numerator, the rates of return on total assets are the same as shown below:

Wilder Company $720,000 = 17.14%$4,200,000

Ingalls Company$648,000 + $120,000 – $48,000 = $720,000

$4,200,000 $4,200,000

= 17.14%



(b) Ingalls Company is the more profitable in terms of return on ordinary share equity. This may be shown as follows:

Ingalls Company $648,000 = 24%$2,700,000

Wilder Company $720,000 = 20%$3,600,000

(Note to instructor: To explain why the difference in rate of return on assets and rate of return on ordinary share equity occurs, the following schedule might be provided to the student.)

Ingalls Company

Funds SuppliedFunds

Supplied

Rate of Return on Funds at

17.14%*Cost of Funds

Accruing to Ordinary Shares

Non-Current $1,200,000 $205,680 $72,000* $133,680Current liabilities 300,000 51,420 0 51,420Share capital 2,000,000 342,800 0 342,800Retained earnings 700,000 119,980 0 119,980

$4,200,000 $719,880 $72,000 $647,880

*Determined in part (a), 17.14%

**The cost of funds is the interest of $120,000 ($1,200,000 X 10%). This interest cost must be reduced by the tax savings (40%) related to the interest.

The schedule indicates that the income earned on the total assets (before interest cost) was $719,880. The interest cost (net of tax) of this income was $72,000, which indicates a net return to the ordinary share equity of $647,880.

(c) The Ingalls Company earned a net income per share of $6.48 ($648,000 ÷ 100,000) while Wilder Company had an income per share of $4.97 ($720,000 ÷ 145,000). Ingalls Company has borrowed a substantial portion of its assets at a cost of 10% and has used these assets to earn a return in excess of 10%. The excess earned on the borrowed assets represents additional income for the shareholders and has resulted in the higher income per share. Due to the debt financing, Ingalls has fewer shares outstanding.



(d) Yes, from the point of view of net income it is advantageous for the shareholders of Ingalls Company to have non-current liabilities out-standing. The assets obtained from incurrence of this debt are earning a higher return than their cost to Ingalls Company.

(e) Book value per share.

Ingalls Company $2,000,000 + $700,000 = $27.00100,000

Wilder Company $2,900,000 + $700,000 = $24.83145,000

EXERCISE 15-20 (15 minutes)

(a) Rate of return on ordinary share equity:

€213,718 = €213,718 = 14.7%€875,000 + €575,000 €1,450,000

Rate of interest paid on bonds payable:€135,000 = 9%

€1,500,000

(b) DeVries Plastics, Inc. is trading on the equity successfully, since its return on ordinary share equity is greater than interest paid on bonds.

Note: Some analysts use after-tax interest expense to compute the bond rate.

*EXERCISE 15-21 (10–15 minutes)

Preference Ordinary Total

(a) Preference shares are non-cumulative, Non-participating (2,000 X $100 X 6%) $12,000

Remainder ($70,000 – $12,000) $58,000 $70,000

(b) Preference shares are cumulative, Non-participating ($12,000 X 3) $36,000

Remainder ($70,000 – $36,000) $34,000 $70,000


*EXERCISE 15-21 (Continued)

Preference Ordinary Total

(c) Preference shares are cumulative, participating $44,444 $25,556 $70,000

The computation for these amounts is as follows:

Preference Ordinary TotalDividends in arrears (2 X $12,000) $24,000 $24,000Current dividend 12,000 12,000Pro-rata share to ordinary

(5,000 X $50 X 6%) $15,000 15,000Balance dividend pro-rata 8,444 10,556 19,000 *

$44,444 $25,556 $70,000

*Additional amount available for participation

($70,000 – $24,000 – $12,000 – $15,000) 19,000

Par value of shares that are to participate

Preference (2,000 X $100) $200,000

Ordinary (5,000 X $50) 250,000 450,000

Rate of participation

$19,000 ÷ $450,000 4.2222%

Participating dividend

Preference, 4.2222% X $200,000 $ 8,444

Ordinary, 4.2222% X $250,000 10,556

$19,000

Note to instructor: Another way to compute the participating amount is as follows:

Preference$200,000

X $19,000 $ 8,444$450,000

Ordinary$250,000

X $19,000 10,556

$19,000$450,000



(a) Preference Ordinary Total

Preference shares are cumulative and fully participating $26,000 $240,000 $266,000


Preference Ordinary TotalDividends in arrears

(5% X $10 X 20,000) $10,000 $ 10,000Current dividend

Preference 10,000Ordinary (5% X $100 X 30,000) $150,000 160,000

Balance dividend pro-rata 6,000 90,000 96,000 *$26,000 $240,000 $266,000

*Additional amount available for participation

($266,000 – $10,000 – $160,000) $ 96,000


($200,000 + $3,000,000) $3,200,000


$96,000 ÷ $3,200,000 3%


Preference, 3% X $200,000 $ 6,000

Ordinary, 3% X $3,000,000 90,000

$ 96,000

Preference$200,000

X $96,000 $ 6,000$3,200,000

Ordinary$3,000,000

X $96,000 90,000

$ 96,000$3,200,000



Note to instructor: Another way to compute the participating amount is as follows:

(b) Preference Ordinary TotalPreference shares are non-cumulative and non-participating $10,000 $256,000 $266,000


Current dividend (preferred)(5% X $10 X 20,000) $ 10,000

Remainder to ordinary($266,000 – $10,000) 256,000

$266,000

(c) Preference Ordinary TotalPreference shares are non-cumulative and participating in distributions in excess of 7% $12,875 $253,125 $266,000


Preference Ordinary TotalCurrent year

Preference (5% X $10 X 20,000) $10,000 $ 10,000Ordinary (5% X $3,000,000) $150,000 150,000

Additional 2% to ordinary(2% X $3,000,000) 60,000 60,000

Balance dividend pro-rata 2,875 43,125 46,000 *$12,875 $253,125 $266,000

*Additional amount available for participation($266,000 – $10,000 – $150,000 – $60,000) $ 46,000

Par value of shares that are to participate($200,000 + $3,000,000) $3,200,000

Rate of participation$46,000 ÷ $3,200,000 1.4375%

Participating dividendPreference 1.4375% X $200,000 $ 2,875Ordinary 1.4375% X $3,000,000 43,125

$ 46,000



Assumptions

(a) (b)Preference,

non-cumulative, and non-participating

Preference, cumulative, and fully

participating

Year Paid-out Preference Ordinary Preference Ordinary

2009 $12,000 $4.80 –0– $ 4.80 –0–2010 $26,000 $6.00 $ .73 $ 7.20 $ .532011 $52,000 $6.00 $2.47 $13.00 $1.302012 $76,000 $6.00 $4.07 $19.00 $1.90

The computations for part (a) are as follows:

2009

Dividends paid..................................................... $12,000Amount due preference (2,500 X $100 X 6%).... $15,000Preference per share ($12,000 ÷ 2,500).............. $4.80Ordinary per share.............................................. –0–

2010

Dividends paid..................................................... $26,000Amount due preference...................................... 15,000 Amount due ordinary.......................................... $11,000Preference per share ($15,000 ÷ 2,500).............. $6.00Ordinary per share ($11,000 ÷ 15,000)............... $ .73

2011

Dividends paid.................................................... $52,000Amount due preference...................................... 15,000 Amount due ordinary.......................................... $37,000Preference per share ($15,000 ÷ 2,500).............. $6.00Ordinary per share ($37,000 ÷ 15,000)............... $2.47



2012

Dividends paid...................................................... $76,000Amount due preference....................................... 15,000 Amount due ordinary........................................... $61,000Preference per share ($15,000 ÷ 2,500)................ $6.00Ordinary per share ($61,000 ÷ 15,000)................. $4.07

The computations for part (b) are as follows:

2009

Dividends paid...................................................... $12,000Amount due preference (2,500 X $100 X 6%)...... $15,000Preference per share ($12,000 ÷ 2,500)................ $4.80Ordinary per share................................................ –0–

2010

Dividends paid...................................................... $26,000Amount due preference

In arrears ($15,000 – $12,000)..................... 3,000Current.......................................................... 15,000

$18,000Amount due ordinary ($26,000 – $18,000).......... $ 8,000Preference per share ($18,000 ÷ 2,500)................ $7.20Ordinary per share ($8,000 ÷ 15,000)................... $ .53



2011

Dividends paid................................................ $52,000Amount due preference

Current (2,500 X $100 X 6%)................. $15,000Amount due ordinary

Current (15,000 X $10 X 6%)................. $ 9,000

Amount available for participation

($52,000 – $15,000 – $9,000)................. $ 28,000


($250,000 + $150,000)............................ $400,000


$28,000 ÷ $400,000................................. 7%


Preference (7% X $250,000).................. $ 17,500

Ordinary (7% X $150,000)...................... $ 10,500

Total amount per share—Preference

Current $15,000

Participation 17,500

$32,500 ÷ 2,500 $13.00

Total amount per share—Ordinary

Current $ 9,000


$19,500 ÷ 15,000 $ 1.30



2012

Dividends paid................................................ $76,000Amount due preference

Current (2,500 X $100 X 6%)................. $15,000Amount due ordinary

Current (15,000 X $10 X 6%)................. $ 9,000

Amount available for participation

($76,000 – $15,000 – $9,000)................. $ 52,000

Par value that is to participate

($250,000 + $150,000)............................ $400,000


$52,000 ÷ $400,000................................. 13%


Preference (13% X $250,000)................ $ 32,500

Ordinary (13% X $150,000).................... $ 19,500

Total amount per share—Preference

Current $15,000


$47,500 ÷ 2,500 $19.00

Total amount per share—Ordinary

Current $ 9,000


$28,500 ÷ 15,000 $ 1.90



(a) Preference OrdinaryEquity

Preference shares........................................ $500,000Ordinary shares............................................ $ 750,000

Retained earningsDividends in arrears (3 years at 6%)........... 90,000

Remainder to ordinary*...................................... 310,000 $590,000 $1,060,000

Shares outstanding............................................ 750,000Book value per share ($1,060,000 ÷ 750,000)..................................... $1.41

*Balance in retained earnings ($700,000 – $40,000 – $260,000)..................... $ 400,000Less: Dividends to preference........................ (90,000 )Available to ordinary......................................... $ 310,000

(b) EquityPreference share.......................................... $ 500,000Liquidating premium.................................... 30,000

Ordinary shares..................................................$ 750,000Retained earnings

Dividends in arrears (3 years at 6%)........... $ 90,000Remainder to ordinary*...................................... 280,000

$1,030,000 $ 620,000

Shares outstanding............................................ 750,000Book value per share ($1,030,000 ÷ 750,000)..................................... $1.37

*Balance in retained earnings ($700,000 – $40,000 – $260,000)..................... $400,000Less: Liquidating premium to preference....... (30,000) Dividends to preference......................... (90,000 )Available to ordinary.......................................... $280,000


TIME AND PURPOSE OF PROBLEMS

Problem 15-1 (Time 50–60 minutes)Purpose—to provide the student with an understanding of the necessary entries to properly account for a corporation’s share transactions. This problem involves such concepts as shares sold for cash, noncash stock transactions, and declaration and distribution of share dividends. The student is required to prepare the respective journal entries and the equity section of the statement of financial position to reflect these transactions.

Problem 15-2 (Time 25–35 minutes)Purpose—to provide the student with an opportunity to record the acquisition of treasury shares and its sale at three different prices. In addition, an equity section of the statement of financial position must be prepared.

Problem 15-3 (Time 25–30 minutes)Purpose—to provide the student with an opportunity to record seven different transactions involving share issuances, reacquisitions, and dividend payments. Throughout the problem the student needs to keep track of the shares outstanding.

Problem 15-4 (Time 20–30 minutes)Purpose—to provide the student with an understanding of the necessary entries to properly account for a corporation’s share transactions. This problem involves such concepts as a lump-sum sale of capital shares and a non-cash stock exchange. The student is required to prepare the journal entries to reflect these transactions.

Problem 15-5 (Time 30–40 minutes)Purpose—to provide the student with an understanding of the proper entries to reflect the reacquisition, and reissuance of a corporation’s shares. The student is required to record these treasury share transactions under the cost method, assuming the FIFO method for purchase and sale purposes.

Problem 15-6 (Time 30–40 minutes)Purpose—to provide the student with an understanding of the necessary entries to properly account for a corporation’s share transactions. This problem involves such concepts as the reacquisition, and reissuance of shares; plus a declaration and payment of a cash dividend. The student is required to prepare the respective journal entries and the equity section of the statement of financial position to reflect these transactions.

Problem 15-7 (Time 15–20 minutes)Purpose—to provide the student with an understanding of the proper accounting for the declaration and payment of cash dividends on both preference and ordinary shares. This problem also involves a dividend arrearage on preference stock, which will be satisfied by the issuance of treasury shares. The student is required to prepare the necessary journal entries for the dividend declaration and payment, assuming that they occur simultaneously.

Problem 15-8 (Time 20–25 minutes)Purpose—to provide the student with an understanding of the accounting effects related to share dividends and share splits. The student is required to analyze their effect on total assets, share capital—ordinary, share premium—ordinary, retained earnings, and total equity.

Problem 15-9 (Time 20–25 minutes)Purpose—to provide the student with an understanding of the effect which a series of transactions involving such items as the issuance and reacquisition of ordinary and preference shares, and a share dividend, have on the company’s equity accounts. The student is required to prepare the equity section of the statement of financial position in proper form reflecting the above transactions.


Time and Purpose of Problems (Continued)

Problem 15-10 (Time 35–45 minutes)Purpose—to provide the student with an understanding of the differences between a share dividend and a share split. Acting as a financial advisor to the Board of Directors, the student must report on each option and make a recommendation.

Problem 15-11 (Time 25–35 minutes)Purpose—to provide the student with an understanding of the proper accounting for the declaration and payment of both a cash and share dividend. The student is required to prepare both the necessary journal entries to record cash and share dividends and the equity section of the statement of financial position, including a note to the financial statements setting forth the basis of the accounting for the share dividend.

Problem 15-12 (Time 35–45 minutes)Purpose—to provide the student a comprehensive problem involving all facets of the equity section. The student must prepare the equity section of the statement of financial position, analyzing and classifying a dozen different transactions to come up with proper accounts and amounts. A good review of Chapter 15.


SOLUTIONS TO PROBLEMS

PROBLEM 15-1

(a)January 11

Cash (20,000 X $16)................................................... 320,000Share Capital—Ordinary (20,000 X $10) ......... 200,000Share Premium—Ordinary................................ 120,000

February 1Machinery.................................................................. 50,000Factory Building........................................................ 160,000Land............................................................................ 270,000

Share Capital—Preference (4,000 X $100)....... 400,000Share Premium—Preference............................ 80,000

July 29Treasury Shares (1,800 X $17)................................. 30,600

Cash.................................................................... 30,600

August 10Cash (1,800 X $14)..................................................... 25,200Retained Earnings (1,800 X $3)................................ 5,400*

Treasury Shares................................................ 30,600

*(The debit is made to Retained Earnings because no Share Premium—Treasury exists.)


PROBLEM 15-1 (Continued)

December 31Retained Earnings..................................................... 37,000

Cash Dividend Payable—Ordinary.................. 5,000*Cash Dividend Payable—Preference............... 32,000**

*Ordinary Share Cash Dividend:Ordinary shares outstanding 20,000Ordinary cash dividend X $.25

$5,000

**(4,000 X 100 X 8%)

December 31Income Summary...................................................... 175,700

Retained Earnings............................................. 175,700

(b) PHELPS CORPORATIONPartial Statement of Financial Position

December 31, 2010

Equity Share capital preference— par value $100 per share, 8% cumulative and nonparticipating, 5,000 shares authorized, 4,000 shares issued and outstanding.............. $400,000 Share capital—ordinary— par value $10 per share, 50,000 shares authorized, 20,000 shares issued and outstanding............ 200,000 $600,000 Share Premium—Preference................................ 80,000 Share Premium—Ordinary.................................... 120,000 200,000 Retained earnings 133,300*

Total equity............................................... $933,300

*($175,700 – $5,400 – $37,000)


PROBLEM 15-2

(a) Feb. 1 Treasury Shares (€19 X 2,000)............... 38,000Cash................................................ 38,000

Mar. 1 Cash (€17 X 800)..................................... 13,600Retained Earnings (€2 X 800)................. 1,600

Treasury Shares (€19 X 800)......... 15,200

Mar. 18 Cash (€14 X 500)..................................... 7,000Retained Earnings (€5 X 500)................. 2,500

Treasury Shares (€19 X 500)......... 9,500

Apr. 22 Cash (€20 X 600)..................................... 12,000Treasury Shares (€19 X 600)......... 11,400Share Premium—Treasury........... 600

(b) CLEMSON COMPANYPartial Statement of Financial Position

April 30, 2010

Equity Share capital—ordinary, €5 par value, 20,000 shares issued, 19,900 shares outstanding.......................... €100,000 Share premium—ordinary............................... €300,000 Share premium—treasury............................... 600 300,600 Retained earnings*.......................................... 445,900

846,500 Less: Treasury shares (100 shares)**........... 1,900

Total equity.............................................. € 844,600

*Retained earnings (beginning balance)........ €320,000 March 1 reissuance......................................... (1,600) March 18 reissuance....................................... (2,500) Net income for period..................................... 130,000 Retained earnings (ending balance)............. € 445,900

**Treasury shares (beginning balance)............ € 0 February 1 purchase (2,000 shares).............. 38,000 March 1 sale (800 shares).............................. (15,200) March 18 sale (500 shares)............................ (9,500) April 12 sale (600 shares)............................... (11,400 )


Treasury shares (ending balance)................. € 1,900


PROBLEM 15-3

HATCH COMPANYPartial Statement of Financial Position

December 31, 2010

Equity Share capital—preference, $20 par, 8%, 180,000 shares issued and outstanding............................................. $ 3,600,000 Share capital—ordinary, $2.50 par, 4,100,000 shares issued, 4,080,000 shares outstanding....................... 10,250,000 13,850,000

Share premium—preference............................ $ 260,000 Share premium—ordinary................................ 27,750,000 Share premium—treasury................................ 10,000 28,020,000 Retained earnings............................................. 4,272,000 Treasury shares (20,000 ordinary shares)...... (200,000 )

Total equity................................................... $45,942,000

Supporting balances are indicated in the following T-Accounts.

Share Capital—Preference Bal. 3,000,000 1. 600,000

3,600,000

Share Premium—Ordinary Bal. 27,000,000 4. 750,000

27,750,000



Share Capital—Ordinary Bal. 10,000,000 3. 250,000 10,250,000

Retained Earnings Bal. 4,500,000

8. 288,000 10. 2,100,0009. 2,040,000

4,272,000

Share Premium—Preference Bal. 200,000 2. 60,000

260,000

Treasury Shares 5. 300,000 6. 100,000

200,000

Share Premium—Treasury 7. 10,000

10,000

1. Jan. 1 30,000 X $20 2. Jan. 1 30,000 X $2 3. Feb. 1 50,000 X $5 4. Feb. 1 50,000 X $15 5. July 1 30,000 X $10 6. Sept. 15 10,000 X $10 7. Sept. 15 10,000 X $1 8. Dec. 31 3,600,000 X 8% 9. Dec. 31 4,080,000* X 50¢10. Dec. 31 Net income

*[(2,000,000 + 50,000) X 2] – 30,000 + 10,000


PROBLEM 15-4

-1-Cash..................................................................................... 10,000

Bonds Payable............................................................ 9,894Share Capital—Preference......................................... 50Share Premium—Preference (€106 – €50)................ 56

-2-Machinery (500 X €16)........................................................ 8,000

Share Capital—Ordinary............................................ 5,000Share Premium—Ordinary......................................... 3,000

(Assuming the shares are regularly traded, the value of the shares would be used.) If the shares are not regularly traded, the machinery would be recorded at its estimated fair value.

-3-Cash..................................................................................... 10,800

Share Capital—Preference......................................... 5,000Share Premium—Preference (€5,974 – €5,000)........ 974Share Capital—Ordinary............................................ 3,750Share Premium—Ordinary (€4,826 – €3,750)............ 1,076

Fair value of ordinary (375 X €14) € 5,250Fair value of preference (100 X €65) 6,500Aggregate € 11,750

Allocated to ordinary: €5,250€11,750 X €10,800 = € 4,826

Allocated to preference: €6,500€11,750 X €10,800 = 5,974

Total allocated € 10,800



-4-Furniture and Fixtures....................................................... 6,500

Share Capital—Preference......................................... 2,500Share Premium—Preference (€3,300 – €2,500)........ 800Share Capital—Ordinary............................................ 2,000Share Premium—Ordinary (€3,200 – €2,000)............ 1,200

Fair value of furniture and equipment €6,500Less: Fair value of ordinary shares (200 X €16) 3,200 Total value assigned to preference shares € 3,300


PROBLEM 15-5

(a) Treasury Shares (380 X £40)............................... 15,200Cash.............................................................. 15,200

(b) Treasury Shares (300 X £45)............................... 13,500Cash.............................................................. 13,500

(c) Cash (350 X £42)................................................... 14,700Treasury Shares (350 X £40)....................... 14,000Share Premium—Treasury (350 X £2)................................................... 700

(d) Cash (110 X £38)................................................... 4,180Share Premium—Treasury.................................. 620

Treasury Shares........................................... 4,800*

*30 shares purchased at £40 = £1,200 80 shares purchased at £45 = 3,600 (Cost of treasury shares sold using FIFO = £ 4,800


PROBLEM 15-6

(a) -1-Treasury Shares (280 X $97)....................................... 27,160

Cash....................................................................... 27,160

-2-Retained Earnings........................................................ 90,400

Dividends Payable [(4,800 – 280) X $20 = $90,400].......................... 90,400

-3-Dividends Payable....................................................... 90,400

Cash....................................................................... 90,400

-4-Cash (280 X $102)......................................................... 28,560

Treasury Shares.................................................... 27,160Share Premium—Treasury (280 X $5)................... 1,400

-5-Treasury Shares (500 X $105)...................................... 52,500

Cash....................................................................... 52,500

-6-Cash (350 X $96)........................................................... 33,600Share Premium—Treasury.......................................... 1,400Retained Earnings........................................................ 1,750

Treasury Shares (350 X $105).............................. 36,750



(b) WASHINGTON COMPANYPartial Statement of Financial Position

December 31, 2011

Equity Share capital—ordinary, $100 par value, authorized 8,000 shares; issued 4,800 shares, 4,650 shares outstanding..................................... $480,000 Retained earnings (restricted in the amount of $15,750 by the acquisition of treasury shares)................................................ 295,850* Treasury shares (150 shares)................................. (15,750)**

Total equity.......................................................... $760,100

*($294,000 – $90,400 + $94,000 – $1,750)

**($52,500 – $36,750)


PROBLEM 15-7

(a) For preference dividends in arrears:

Retained Earnings.................................................. 18,000Treasury Shares............................................. 18,000*

*1,500 treasury shares issued as dividend 1,500 X $12 = $18,000

For 6% preference current year dividend:

Retained Earnings............................................... 18,000Cash............................................................. 18,000*

*(6% X $300,000)

For $.30 per share ordinary dividend:

Retained Earnings............................................... 89,610Cash............................................................. 89,610*

*Since all preference dividends must be paid before the ordinary dividend, outstanding ordinary shares include—

As of Dec. 31, 2010 (300,000 – 2,800)................. 297,200 sharesPreference distribution....................................... 1,500 shares

298,700 sharesOrdinary dividend................................................ .30 /shareAmount of ordinary cash dividend.................... $ 89,610

(b) The suggested cash dividend could be paid even if the jurisdiction did restrict the retained earnings balance in the amount of the cost of treasury shares. Total dividends would be $125,160,* which is ade-quately covered by the cash balance. The retained earnings balance, after adding the 2011 net income (estimated at $77,000), is sufficient to cover the dividends.**



*Preference dividends in arrears (6% X $300,000).... $ 18,000Current preference dividend (6% X $300,000)......... 18,000Ordinary dividend ($.30 X 297,200)........................... 89,160 Total cash dividend.................................................... $125,160

**Beginning balance...................................................... $105,000Estimated net income................................................ 77,000 Total balance available.............................................. 182,000If restricted by cost of treasury shares.................... (33,600 )Available to pay dividends........................................ $148,400


PROBLEM 15-8

Transactions:

(a) Assuming Myers Co. declares and pays a €.10 per share cash dividend.(1) Total assets—decrease €4,000 [(€20,000 ÷ €5) X €1](2) Share capital—ordinary—no effect(3) Share premium—ordinary—no effect(4) Retained earnings—decrease €4,000(5) Total equity—decrease €4,000

(b) Myers declares and issues a 10% share dividend when the market price of the stock is €14.(1) Total assets—no effect(2) Share capital—ordinary—increase €2,000 (4,000 X 10%) X €5(3) Share premium—ordinary—increase €3,600 (400 X €14) – €2,000(4) Retained earnings—decrease €5,600 (€14 X 400)(5) Total equity—no effect

(c) Myers declares and issues a 30% share dividend when the market price of the stock is €15 per share.(1) Total assets—no effect(2) Share capital—ordinary—increase €6,000 (4,000 X 30%) X €5(3) Share premium—ordinary—no effect(4) Retained earnings—decrease €6,000(5) Total equity—no effect

(d) Myers declares and distributes a property dividend(1) Total assets—decrease €14,000 (2,000 X €7)— €6,000 gain less

€20,000 dividend.(2) Share capital—ordinary—no effect(3) Share premium—ordinary—no effect(4) Retained earnings—decrease €14,000—€6,000 gain less €20,000

dividend.(5) Total equity—decrease €14,000



Note:

The journal entries made for the above transaction are:

Investments in ABC Stock (€10 – €7) X 2,000.............. 6,000

Gain on Appreciation of Securities....................... 6,000

(To record increase in value of

securities to be issued)

Retained Earnings (€10 X 2,000)................................... 20,000

Investments in ABC Stock..................................... 20,000

(To record distribution of property dividend)

(e) Myers declares a 2-for-1 share split

(1) Total assets—no effect

(2) Share capital—ordinary—no effect

(3) Share premium—ordinary—no effect

(4) Retained earnings—no effect

(5) Total equity—no effect


PROBLEM 15-9

VICARIO CORPORATION

Partial Statement of Financial Position

December 31, 2012

Equity

Share capital—preference, $100 par value

10,000 shares authorized, 5,000 shares

issued & outstanding.............................................. $500,000

Share capital—ordinary, $50 par value

15,000 shares authorized,

8,000 shares issued 7,700 shares outstanding.... 400,000 $900,000

Share premium—preference..................................... 65,000

Share premium—ordinary......................................... 59,000*

Share premium—treasury (preference).................... 4,700 128,700

Retained earnings...................................................... 237,400**

Less: Treasury shares (300 shares—ordinary)....... 19,200 Total equity........................................................... $1,246,900

*[($57 – $50) X 7,000 + ($60 – $50) X 1,000]

**$610,000 – $312,600 – ($60 X 1,000 shares)


PROBLEM 15-10

To: Oregon Inc. Board of Directors

From: Good Student, Financial Advisor

Date: Today

Subject: Report on the effects of a share dividend and a share split

INTRODUCTION

As financial advisor to the Board of Directors for Oregon Inc., I have been asked to report on the effects of the following options for creating interest in Oregon Inc. shares: a 20% share dividend, a 100% share dividend, and a 2-for-1 share split. The board wishes to maintain equity as it presently appears on the most recent statement of financial position. The Board also wishes to generate interest in share purchases, and the current market value of the shares ($110 per share) may be discouraging potential investors. Finally, the Board thinks that a cash dividend at this point would be unwise.

RECOMMENDATION

In order to meet the needs of Oregon Inc., the board should choose a 2-for-1 share split. The share split is the only option which would not change the dollar balances in the equity section of the company’s statement of financial position.

DISCUSSION OF OPTIONS

The three above-mentioned options would all result in an increased number of ordinary shares outstanding. Because the shares would be distributed on a pro rata basis to current shareholders, each shareholder of record would maintain his/her proportion of ownership after the declaration. All three options would probably generate significant interest in the shares.



A 20% SHARE DIVIDEND

This option would increase the shares outstanding by 20 percent, which translates into 800,000 additional shares of $10 par value.

The problem with this type of share dividend is that IFRS requires these shares to be accounted for at their current fair value if it significantly exceeds par.

The following journal entry must be made to record this dividend.

Retained Earnings ($110 X 800,000)......................... 88,000,000Ordinary Share Dividend Distributable............ 8,000,000Share Premium—Ordinary................................ 80,000,000

Although the Ordinary Share Dividend Distributable and the Share Premium accounts increase, Retained Earnings decreases dramatically. This reduction in Retained Earnings may hinder Oregon Inc.’s success with the subsequent share offer.

A 100% SHARE DIVIDEND

This option would double the number of $10 par value ordinary shares currently issued and outstanding. Because this type of dividend is considered, in substance, a share split, the shares do not have to be accounted for at fair value. Instead, Retained Earnings is reduced only by the par value of the additional shares, while Ordinary Share Dividend Distributable and, later, Share Capital—Ordinary are increased for that same amount. However, when 4,000,000 shares are already issued and outstanding, the reduction in Retained Earnings reflecting the share dividend is still great: $40,000,000. In addition, no increase in any Share Premium account occurs.

The following journal entry would be made to record the declaration of this dividend:

Retained Earnings ($10 X 4,000,000)....................... 40,000,000Ordinary Share Dividend Distributable............ 40,000,000



A 2-FOR-1 SHARE SPLIT

This option doubles the number of shares issued and outstanding; however, it also cuts the par value per share in half. No accounting treatment beyond a memorandum entry is required for the split because the effect of splitting the par value cancels out the effect of doubling the number of shares. Therefore, Retained Earnings remains unchanged as does the Share Capital—Ordinary and Share Premium—Ordinary accounts. In addition, the decreased market value will encourage investors who might otherwise consider the shares too expensive.

CONCLUSION

To generate the greatest interest in Oregon Inc. shares while maintaining the present balances in the equity section of the statement of financial position, you should opt for the 2-for-1 share split.


PROBLEM 15-11

(a)May 5, 2010

Retained Earnings............................................... 1,800,000Dividends Payable......................................... 1,800,000

(Declaration of cash dividend of $0.60 per share on 3,000,000 shares)

June 30, 2010Dividends Payable.............................................. 1,800,000

Cash................................................................ 1,800,000

(b)November 30, 2010

Retained Earnings............................................... 6,120,000Ordinary Share Dividend Distributable................................................ 1,800,000Share Premium—Ordinary............................ 4,320,000

(Share dividend of 6%, 180,000shares, at $34 per share)

December 31, 2010Ordinary Share Dividend Distributable............... 1,800,000

Share Capital—Ordinary................................... 1,800,000

(c) EARNHART CORPORATIONPartial Statement of Financial Position

December 31, 2010

Equity Share capital—ordinary $10 par value, issued 3,180,000 shares...............................................

$31,800,000

Share premium—ordinary.............................................. 9,320,000 Retained earnings........................................................... 20,780,000

Total equity................................................................... $61,900,000



Statement of Retained EarningsFor the Year Ended December 31, 2010

Balance, January 1.................................... $24,000,000Add: Net income...................................... 4,700,000

28,700,000Less: Dividends on ordinary shares:

Cash................................................ $1,800,000 Share (see note)............................. 6,120,000 7,920,000

Balance December 31............................... $20,780,000

Schedule of Share Premium—OrdinaryFor the Year Ended December 31, 2010

Balance January 1..................................... $5,000,000Excess of fair value over par value of 180,000 ordinary shares distributed as a dividend (see note).......................... 4,320,000 Balance December 31............................... $9,320,000

Note: The 6% share dividend (180,000 shares) was declared on November 30, 2010. For the purposes of the dividend, the shares were assigned a price of $34 per share. The par value of $10 per share ($1,800,000) was credited to Share Capital—Ordinary and the excess of $24 ($34 – $10) per share ($4,320,000) to Share Premium—Ordinary.


PROBLEM 15-12

PENN COMPANYPartial Statement of Financial Position

June 30, 2011

Equity 8% Share capital—preference, $25 par value, cumulative and non-participating, 100,000 shares authorized, 40,000 shares issued and outstanding—Note A............. $1,000,000

Share capital—ordinary shares, $10 par value, 300,000 shares authorized, 115,400 shares issued with 1,500 shares held in the treasury..... 1,154,000 $2,154,000

Share premium—preference.................................... 760,000 Share premium—ordinary........................................ 2,821,800* Share premium—treasury........................................ 1,500 3,583,300

Retained earnings..................................................... 409,200 Less: Treasury shares, (1,500 shares)................... 58,500

Total equity.......................................................... $6,088,000

Note A: Penn Company is in arrears on the preference shares in the amount of $40,000.

*Share Premium—Ordinary: Issue of 85,000 shares X ($31 – $10) $1,785,000 Plot of land 170,000 Issue of 20,000 shares (3/1/09) 640,000 [20,000 X ($42 – $10)] 5,400 shares as dividend [5,400 X ($52 – $10)] 226,800

$2,821,800



Account Balances

Share Capital—Ordinary 850,000 50,000

200,00054,000

1,154,000

Share Capital—Preference1,000,000

Treasury Shares 78,000

19,50058,500

Share Premium—Ordinary 1,785,000 170,000

640,000226,800

2,821,800

Share Premium—Preference760,000

Share Premium—T.S.1,500

Retained Earnings 690,000

280,800 40,000

40,000 409,200

Note that the Penn Company is authorized to issue 300,000 shares of $10 par value ordinary shares and 100,000 shares of $25 par value, cumulative and nonparticipating preference shares.



Entries supporting the balances.

Entries1. Cash.................................................................. 2,635,000

Share Capital—Ordinary.......................... 850,000Share Premium—Ordinary...................... 1,785,000

2. Land.................................................................. 220,000Share Capital—Ordinary.......................... 50,000Share Premium—Ordinary...................... 170,000

3. Cash.................................................................. 840,000Share Capital—Ordinary.......................... 200,000Share Premium—Ordinary...................... 640,000

At the beginning of the year, Penn had 110,000 ordinary shares out-standing, of which 85,000 shares were issued at $31 per share, resulting in $850,000 (85,000 shares at $10) of share capital and $1,785,000 of share premium on ordinary shares (85,000 shares at $21). The 5,000 shares exchanged for a plot of land would be recorded at $50,000 of share capital and $170,000 of share premium (use the current fair value of the land on July 24 to value the share issuance). The 20,000 shares issued in 2009 at $42 a share resulted in $200,000 of share capital and $640,000 of share premium.

Preference Shares

Cash.................................................................. 1,760,000Share Capital—Preference...................... 1,000,000Share Premium—Preference................... 760,000

Treasury Shares

Nov. 30 Treasury Shares....................................... 78,000Cash..................................................... 78,000

June 30 Cash.......................................................... 21,000Share Premium—Treasury................. 1,500Treasury Shares.................................. 19,500



The 2,000 treasury shares purchased resulted in a debit balance of treasury shares of $78,000. Later, 500 shares were sold at $21,000, which brings the balance down to $58,500 (1,500 shares at $39 per share).

The sale of the treasury shares above cost ($21,000 minus $19,500 cost) is recorded in a separate share premium amount.

Share Dividend

Dec. 15 Retained Earnings.................................... 280,800**Share Capital—Ordinary.................... 54,000*Share Premium—Ordinary................. 226,800

*Shares outstanding, beginning of year: 110,000Treasury Shares (2,000 )

108,000 X 5% = 5,400X $10 Par$54,000

**5,400 Shares X $52

The 5% share dividend resulted in an increase of 5,400 shares. Recall that there were 110,000 shares outstanding at the beginning of the year. The purchase of 2,000 treasury shares occurred before the share dividend, bringing the number of shares outstanding at the time of the dividend (December 2010) to 108,000 shares. The resale of 500 treasury shares occurred after the share dividend.

The issuance of 40,000 preference shares at $44 resulted in $1,000,000 (40,000 shares at $25) of share capital—preference and $760,000 (40,000 shares at $19) of share premium—preference.

Retained Earnings

The cash dividends only affect the retained earnings. Note that the preference shares are in arrears for the dividends that should have been declared in June 2011. Ending retained earnings is the beginning balance of $690,000 plus net income of $40,000, less the preference dividend of $40,000 and the ordinary share dividend of $280,800 (5,400 shares at $52), resulting in an ending balance of $409,200.


TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS

CA 15-1 (Time 10–20 minutes)Purpose—to provide the student with some familiarity with the applications of the ordinary share system. This case requires the student to analyze the concept dealing with the dilution of ownership interest and the establishment of any necessary corrective actions to compensate an existing shareholder for this dilution effect.

CA 15-2 (Time 15–20 minutes)Purpose—to provide the student with an opportunity to discuss the bases for recording the issuance of shares in exchange for non-monetary assets.

CA 15-3 (Time 25–30 minutes)Purpose—to provide a five-part theory case on equity based on the IASB conceptual framework. It requires defining terms and analyzing the effects of equity transactions on financial statement elements.

CA 15-4 (Time 25–30 minutes)Purpose—to provide the student with an understanding of the conceptual framework which underlies a share dividend and a share split. The student is required to explain what a share dividend is, the amount of retained earnings to be capitalized in connection with a share dividend, and how it differs from a share split both from a legal standpoint and an accounting standpoint. This case also requires an explanation of the various reasons why a corporation declares a share dividend or a share split.

CA 15-5 (Time 15–20 minutes)Purpose—to provide the student with an understanding of the theoretical concepts and implications that underlie the issuance of a share dividend. The student is required to discuss the arguments against either considering the share dividend as income to the recipient or issuing share dividends on treasury shares.

CA 15-6 (Time 20–25 minutes)Purpose—to provide the student with a situation containing a cash dividend declaration, a share dividend, and a reacquisition and reissuance of shares requiring the student to explain the accounting treatment.

CA 15-7 (Time 10–15 minutes)Purpose—to provide an opportunity for the student to consider and discuss the ethical issues involved when the control of a corporation is at stake. The student should recognize the potential conflict between the CEO’s personal will and the responsibility and accountability the CEO has to the shareholders.


SOLUTIONS TO CONCEPTS FOR ANALYSIS

CA 15-1

(a) To share proportionately in any new issues of shares of the same class (the preemptive right).

(b) Derek Wallace bought an additional $100,000 par value shares. His original ownership was $200,000 ($250,000 X 80%). Thus he increased his ownership by 100/200 (50%). This imbalance can be corrected by issuing to Ms. Baker, at par, shares equal to 50% of her present holdings of $25,000 or shares with a par value of $12,500. Other shareholders should also be offered the right to purchase shares equal to 50% of their holdings in order that all shareholders may retain the same proportionate interest as before the issuance of additional shares.

(c) No information is given with respect to the fair value of the shares. In this situation, an estimate for fair value could be developed based on market transactions involving comparable assets. Otherwise, discounted expected cash flows could be used to approximate fair value. In this closely held company, and in the absence of reliable fair value data, the book value might be used for the computation of the amount of the cash settlement.

Book value of Ms. Baker’s ordinary shares, June 30, 2010, before issuance of additional shares, 25/250 X $422,000...................................... $42,200Book value after issuance of additional shares to Derek Wallace, 25/350 X $522,000....................................................................................... (37,286)Loss in book value and amount of cash settlement........................................ $ 4,914

CA 15-2

(a) The general rule to be applied when shares are issued for services or property other than cash is that companies should record the shares issued at the fair value of the goods or services received, unless that fair value cannot be measured reliably. If the fair value of the goods or services cannot be measured reliably, use the fair value of the shares issued. If a company cannot readily determine either the fair value of the shares it issues or the property or services it receives, it should employ an appropriate valuation technique. Depending on available data, the valuation may be based on market transactions involving comparable assets or the use of discounted expected future cash flows. Companies should avoid the use of the book, par, or stated values as a basis of valuation for these transactions.

(b) If the fair value of the land can be measured reliably, it is used as a basis for recording the exchange. The fair value could be determined by observing the cash sales price of similar pieces of property or through independent appraisals.

(c) If the fair value of the land cannot be measured reliably, but the fair value of the shares issued is determinable, the fair value of the shares is used as a basis for recording the exchange. If the shares are traded on an exchange, the fair value can be determined from that day’s cash sales of the shares. If the shares are traded over the counter, recent sales or bid prices can be used to estimate fair value.

(d) If Martin intentionally records this transaction at an amount greater than fair value, both assets and equity will be overstated. This overvaluation of equity from the inflated asset value is referred to as watered shares. This excess can be eliminated by writing down the overvalued assets with a corresponding charge to the appropriate equity accounts.


CA 15-3

(a) Equity, or net assets, is the residual interest in the assets of the entity after deducting all its liabilities; in other words, equity equals assets less liabilities. Assets are resources controlled by the entity as the result of past events and from which future economic benefits are expected to flow to the entity. Liabilities are present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

(b) Transactions or events that change equity include revenues and expenses, gains and losses, investments by owners, and distributions to owners.

(c) Generally, investments by owners cause an increase in assets in addition to the increase in equity.

(d) Dividends generally initially cause an increase in liabilities but eventually cause a decrease in assets in addition to the decrease in equity. The purchase of treasury shares causes a decrease in assets in addition to the decrease in equity.

(e) Some examples of changes within equity that do not change the total amount of equity are retirement of treasury shares, conversion of preference shares into ordinary shares, share dividends, and retained earnings appropriations.

CA 15-4

(a) A share dividend is the issuance by a corporation of its own shares to its shareholders on a prorata basis without receiving payment therefor. The share dividend results in an increase in the amount of the legal or share capital and share premium of the enterprise. The dividend may be charged to retained earnings or to any other equity account that is not a part of legal capital.

(1) From the legal standpoint a share split is distinguished from a share dividend in that a split results in an increase in the number of shares outstanding and a corresponding decrease in the par or stated value per share. A share dividend, though it results in an increase in the number of shares outstanding, does not result in a decrease in the par or stated value of the shares.

(2) The major distinction is that a share dividend requires a journal entry to decrease retained earnings and increase paid-in capital, while there is no entry for a share split. Also, from the accounting standpoint the distinction between a share dividend and a share split is dependent upon the intent of the board of directors in making the declaration. If the intent is to give to shareholders some separate evidence of a part of their prorata interests in accumulated corporate earnings, the action results in a share dividend. If the intent is to issue enough shares to reduce the market price per share, the action results in a share split, regardless of the form it may take. In other words, if the action takes the form of a share dividend but reduces the market price markedly, it should be considered a share split. Such reduction will seldom occur unless the number of shares issued is at least 20% to 25% of the number previously outstanding.

(b) The usual reason for issuing a share dividend is to give the shareholders something on a dividend date and yet conserve working capital.

A share dividend that is charged to retained earnings reduces the total accumulated earnings, and all share dividends reduce the per share earnings. Issuing a share dividend to achieve these ends would be a public relations gesture in that the public would be less likely to criticize the corporation for high profits or undue retention of earnings.


CA 15-4 (Continued)

A share dividend also may be issued for the purpose of obtaining a wider distribution of the shares. Although this is the main consideration in a stock split, it may be a secondary consideration in the issuance of a share dividend. The issuance of a series of share dividends will accomplish the same objective as a stock split.

A share split is intended to obtain wider distribution and improved marketability of shares by means of a reduction in the market value of the company’s shares.

(c) The amount of retained earnings to be capitalized in connection with a share dividend (in the accounting sense) might be (1) the legal minimum (usually par or stated value), (2) the average share capital per outstanding share, or (3) the market value of the shares.

The third basis is generally recommended on the grounds that recipients tend to regard the market value of the shares received as a dividend as the amount of earnings distributed to them. If the corporation in such cases does not capitalize an amount equal to the fair value of the shares distributed as a dividend, there is left in the corporation’s retained earnings account an amount of earnings that the shareholders believe has been distributed to them. This amount would be subject to further share dividends or to cash dividends. The recipients might thus be misled into believing that the company’s distributions—and earnings—are greater than they actually are.

If the per share market value of the shares is materially reduced as a result of a distribution (usually 20%–25% of shares outstanding or more), no matter what form the distribution takes, the action is in substance a share split and should be so designated and treated as such.

CA 15-5

(a) The case against treating an ordinary share dividend as income is supported by a majority of accounting authorities. It is based upon “entity” and “proprietary” interpretations.

If the corporation is considered an entity separate from shareholders, the income of the corpora-tion is corporate income and not income to shareholders, although the equity of the shareholders in the corporation increases as income to the corporation increases. This position is consistent with the interpretation that a dividend is not income to the recipient until it is realized as a result of a division, distribution, or severance of corporate assets. The share dividend received merely redistributes each stockholder’s equity over a larger number of shares. Selling the share dividend under this interpretation has the effect of reducing the recipient’s proportionate share of the corporation’s equity.

A similar position is based upon a “proprietary” interpretation. Income of the corporation is considered income to the owners and, hence, share dividends represent only a reclassification of equity since there is no increase in total proprietorship.

(b) The case against issuing share dividends on treasury shares rests principally upon the argument that shares reacquired by the corporation is a “reduction of equity” through the payment of cash to reduce the number of outstanding shares. According to this view, the corporation cannot obtain a proprietary interest in itself when it reacquires its own shares. The retained earnings are con-sidered divisible only among the owners of outstanding shares and only the outstanding shares are entitled to a share dividend. In those states that permit treasury shares to participate in the distribution accompanying a share dividend or share split, practice is influenced by the planned use of the treasury shares (such as, the issuance of treasury shares in connection with employee share options). Unless there are specific uses for the treasury shares, no useful purpose is served by issuing additional shares to treasury.


CA 15-6

(a) Mask Company should account for the purchase of the treasury shares on August 15, 2010, by debiting Treasury Shares and crediting Cash for the cost of the purchase (1,000 shares X €18 per share). Mask should account for the sale of the treasury shares on September 14, 2010, by debiting Cash for the selling price (500 shares X $20 per share), crediting Treasury Shares for cost (500 shares X €18 per share), and crediting Share Premium—Treasury for the excess of the selling price over the cost (500 shares X €2 per share). The remaining treasury shares (500 shares X €18 per share) should be presented separately in the equity section of Mask’s December 31, 2010, statement of financial position as an unallocated reduction of equity. These shares are considered issued but not part of ordinary shares outstanding.

(b) Mask should account for the share dividend by debiting Retained Earnings for €21 per share (the market value of the shares in October 2010, the date of the share dividend) multiplied by the 1,950 shares distributed. Mask should then credit Share Capital—Ordinary for the par value of the ordinary shares (€10 per share) multiplied by the 1,950 shares distributed, and credit Share Premium—Ordinary for the excess of the market value (€21 per share) over the par value (€10 per share) multiplied by the 1,950 shares distributed. Total equity does not change, but, because this is considered a small share dividend, recognition has been made of capitalization of retained earnings equivalent to the market value of the additional shares resulting from the share dividend.

(c) Mask should account for the cash dividend on December 20, 2010, the declaration date, by debiting Retained Earnings and crediting Cash Dividends Payable for €1 per share multiplied by the number of shares outstanding 21,450 (20,000 – 1,000 + 500 + 1,950). A cash dividend is a distribution to the corporation’s shareholders. The liability for this distribution is incurred on the declaration date, and it is a current liability because it is payable within one year (January 10, 2011). The effect of the cash dividend on Mask’s statement of financial position at December 31, 2010, is an increase in current liabilities and a decrease in retained earnings.

CA 15-7

(a) The stakeholders are the dissident shareholders, the other shareholders, potential investors, creditors, and Kenseth.

(b) The ethical issues are honesty, job security, and personal responsibility to others. That is, by using her inside information and her authority to do the buy-back, she can benefit herself at the potential expense of other stakeholders.

(c) It is important for Kenseth to consider what is good for the corporation, not just for her (in finance terminology, an agency issue). Kenseth should consider the following questions: (1) Are there better uses for the cash? (2) Can she possibly win over the dissidents in some other way? (3) Would this buyout be in the long-term best interest of all parties?


FINANCIAL REPORTING PROBLEM

(a) M&S’s does not have any preference shares.

(b) M&S’s ordinary shares have a par value of 25p per share. Like many companies, the par value of M&S’s ordinary shares is small relative to its market value.

(c) At 29 March, 2008, M&S had 1,586.5 million ordinary shares issued. This represents 49.6 percent (3,200,000) of M&S’s authorized ordinary shares.

(d) At 29 March, 2008 and 31 March, 2007, M&S had 1,586.5 million and 1,699.8 million ordinary shares outstanding, respectively.

(e) The cash dividends caused M&S’s Retained Earnings to decrease by £343.6 million.

(f) Return on ordinary share equity:

2008: £821/[£1,964 + £1,648.2/2] = 45.5%

2007: £659.9/[£1,648.2 + £1,203.7/2] = 46.3%

(g) Payout ratio:

2008: £343.6/£821 = 41.9%

2007: £260.6/£659.9 = 39.5%


COMPARATIVE ANALYSIS CASE

(a) Par value:Cadbury, 10p per share.Nestlé, CHF0.10 per share.

(b) Percentage of authorized shares issued:Cadbury, 1,352,990,574 ÷ 2,500,000,000 = 54.1%.Nestlé, 3,830,000,000 ÷ 3,830,000,000 = 100%.

(c) Treasury shares, year-end 2008:Cadbury, 10,000,000 shares.Nestlé, 214,392,760 shares.

(d) Ordinary shares outstanding, year-end 2008:Cadbury, 1,352,990,574 – 10,000,000 = 1,342,990,574.Nestlé, 3,830,000,000 – 214,392,760 = 3,615,607,240.

(e) Cadbury declared cash dividends in 2008, reducing equity by £73,000,000 (5.3 p/share).

Nestlé declared cash dividends in 2008, reducing equity by CHF4,573 million (12.2 CHF/share).

(f) Rate of return on ordinary share equity.

2008:

Cadbury£366

= 9.5%£3,534 + £4,173

2

NestléCHF19,051

= 34.7%CHF54,916 + CHF54,776

2


COMPARATIVE ANALYSIS CASE (Continued)

2007:

Cadbury£407

= 10.4%£4,173 + £3,688

2

NestléCHF11,382

= 21.2%CHF54,776 + CHF52,848

2

During 2007 and 2008, Nestlé earned a significantly higher return on its ordinary share equity.

(g) Payout ratios for 2008.

Cadbury£73

= 19.9%£366

NestléCHF4,573*

= 24.0%CHF19,051

*Based on dividends paid.


FINANCIAL STATEMENT ANALYSIS CASES

CASE 1

(a) Management might purchase treasury shares to provide to share-holders a tax-efficient method for receiving cash from the corporation. In addition, it might have to repurchase shares to have them available to issue to people exercising options to purchase shares, or manage-ment might purchase treasury shares because it feels that its share price is too low. It may believe that by purchasing shares it is signalling to the market that the price is too low. Management might also use excess cash to purchase shares to ward off a hostile takeover. Finally, management might purchase shares in an effort to change its capital structure. If it purchases shares and issues debt (or at least does not retire debt), it will increase the percentage of debt in its capital structure.

(b) Earnings per share is calculated by dividing net income by the weighted-average number of shares outstanding during the year.

If shares are reduced by treasury share purchases, the denominator (weighted-average number of shares outstanding) is reduced. As a result, earnings per share is often increased. However, because corporate assets are reduced by the purchase of the treasury shares, earnings potential may decrease. If this occurs, the effect on earnings per share may be mitigated.

(c) One measure of solvency is the ratio of debt divided by total assets. This ratio shows how many dollars of assets are backing up each dollar of debt, should the company become financially troubled. For 2009 and 2008, this can be calculated as follows:

2009 2008

($38,059 ÷ $78,770) = .48 ($36,965 ÷ $76,008) = .49

This represents a slight decrease in the ratio of debt to total assets. It may be determined that BHP Billiton’s solvency is improving, but it should definitely be watched, and in comparison to industry averages.


FINANCIAL STATEMENT ANALYSIS CASES

CASE 2

(a) The date of record marks the time when ownership of the outstanding shares is determined for dividend purposes. This in turn identifies which shareholders will receive the share dividend. This date is also used when a share split occurs. The date of distribution is when the additional shares are distributed (issued) to shareholders.

(b) The purpose of a share split is to increase the marketability of the shares by lowering its market value per share. This may make it easier for the corporation to issue additional shares.

(c) The effects are (1) no effect, (2) no effect, (3) increase, and (4) decrease.


ACCOUNTING, ANALYSIS, AND PRINCIPLES

ACCOUNTING

January 15, 2010

Retained Earnings ($1.05 X 60,000).................. 63,000Cash......................................................... 63,000

April 15, 2010

Retained Earnings [(10% X 60,000) X $14]....... 84,000Share Capital—Ordinary........................ 60,000Share Premium—Ordinary..................... 24,000

May 15, 2010

Treasury Shares (2,000 X $15).......................... 30,000Cash......................................................... 30,000

November 15, 2010

Cash ($18 X 1,000)............................................. 18,000Share Premium—Treasury.................... 3,000Treasury Shares..................................... 15,000

December 31, 2010

Income Summary............................................... 370,000Retained Earnings.................................. 370,000


ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued)

The balances are indicated in the following partial statement of financial position:

AGASSI CORPORATIONStatement of Financial Position (partial)

December 31, 2010

Equity Share capital—ordinary, $10 par value, 66,000 shares issued and outstanding(1).................................................. $ 660,000 Share premium—ordinary(2)..................................... 527,000 Retained earnings(3).................................................. 843,000 Treasury shares(4)..................................................... (15,000 )

Total equity........................................................... $2,015,000

(1) $600,000 + $60,000(2) $500,000 + $24,000 + $3,000(3) $620,000 – $63,000 – $84,000 + $370,000(4) $30,000 – $15,000

ANALYSIS

Payout ratio: $63,000 ÷ $370,000 = 17%

Return on ordinary share equity: $370,000 ÷ [($1,720,000 + $2,105,000) ÷ 2] = 19.3%.

PRINCIPLES

Treasury shares sold above or below cost do not result in gains or losses because treasury shares do not meet the definition of an asset. Rather, they are unissued equity. Furthermore, gains or losses should not be recorded, because share repurchases and reissues are transactions with its own shareholders; the effects of such transactions should not be recorded in income.


PROFESSIONAL RESEARCH

(1) IAS 1 addresses disclosure of information about capital structure.

(2) An entity shall disclose the following, either in the statement of financial position or the statement of changes in equity, or in the notes:

(a) for each class of share capital:(i) the number of shares authorised;(ii) the number of shares issued and fully paid, and issued but

not fully paid;(iii) par value per share, or that the shares have no par value;(iv) a reconciliation of the number of shares outstanding at the

beginning and at the end of the period;(v) the rights, preferences and restrictions attaching to that class

including restrictions on the distribution of dividends and the repayment of capital;

(vi) shares in the entity held by the entity or by its subsidiaries or associates; and

(vii) shares reserved for issue under options and contracts for the sale of shares, including terms and amounts; and

(b) a description of the nature and purpose of each reserve within equity (para. 79).

An entity shall present, either in the statement of changes in equity or in the notes, the amount of dividends recognised as distributions to owners during the period, and the related amount per share (para. 107).

In paragraph 106, the components of equity include, for example, each class of contributed equity, the accumulated balance of each class of other comprehensive income and retained earnings (para. 108).


PROFESSIONAL RESEARCH (Continued)

Changes in an entity’s equity between the beginning and the end of the reporting period reflect the increase or decrease in its net assets during the period. Except for changes resulting from transactions with owners in their capacity as owners (such as equity contributions, reacquisitions of the entity’s own equity instruments and dividends) and transaction costs directly related to such transactions, the overall change in equity during a period represents the total amount of income and expense, including gains and losses, generated by the entity’s activities during that period (para. 109).

IAS 8 requires retrospective adjustments to effect changes in accounting policies, to the extent practicable, except when the transition provisions in another IFRS require otherwise. IAS 8 also requires restatements to correct errors to be made retrospectively, to the extent practicable. Retrospective adjustments and retrospective restatements are not changes in equity but they are adjustments to the opening balance of retained earnings, except when an IFRS requires retrospective adjustment of another component of equity. Paragraph 106(b) requires disclosure in the statement of changes in equity of the total adjustment to each component of equity resulting from changes in accounting policies and, separately, from corrections of errors. These adjustments are disclosed for each prior period and the beginning of the period.


PROFESSIONAL SIMULATION

EXPLANATION

(a) Common stock ordinary shares represents an owner’s claim against a portion of the total assets of the corporation. As a result, it is a residual interest. It therefore is part of equity.

(b) Treasury shares are not an asset. When treasury shares are purchased, a reduction occurs in both assets (cash) and equity. It is inappropriate to imply that a corporation can own part of itself. Treasury shares may be sold to obtain funds, but that possibility does not make it an asset. When a corporation buys back some of its own outstanding shares, it has reduced its capitalization, but it has not acquired an asset.

(c) “Accumulated other comprehensive loss” is the sum of all previous “other comprehensive income and loss” amounts. A number of items may be included in the accumulated other comprehensive loss. Among these items are foreign currency translation adjustments, unrealized hold-ing gains and losses for non-trading equity investments and others.

(d) The accumulated deficit is larger in the current year because AMR, like many other major airlines, reported a net loss of $761 million. AMR did not pay dividends in the current year, which would reduce retained earnings.

ANALYSIS

$(581) ÷ 161.156* = $(3.61)

*(182,350,259 – 21,194,312 treasury shares)

Thus, AMR’s net worth is negative due to Treasury Shares and Accumu-lated Losses.


Documents

Ch15